Financial leverage for European insurance and reinsurance firms is expected to increase in 2017 as companies take advantage of low-interest rates and capital optimisation, according to a report by rating agency Moody’s Investors Service.
Moody’s says four key factors are driving this trend; new subordinated debt issuances boosting Solvency II ratios, favourable credit market conditions encouraging pre-financing, capital optimisation actions which are likely to drive up the proportion of debt to equity, and quality of capital playing an increasing role in defining the optimal capital.
Since its peak of 32.8 percent in 2008, financial leverage for Europe’s biggest re/insurers has steadily dropped down to 23.8 percent in 2015, when it bottomed out and stabilised, and Moody’s says market conditions in 2017 will likely see this percentage begin to swing back up.
In the last two years, European insurers and reinsurers issued high volumes of hybrid debt to cushion their Solvency II capital ratios from the impact of falling interest rates and weak financial markets.
And with the 2017 European market being rocked with uncertainties from Brexit and the potential outcome of several European elections, Associate Managing Director at Moody’s, Antonello Aquino, said he expected these factors to continue to drive European re/insurers to “resume issuing material amounts of hybrid debt” as a cushion against ensuing financial market volatility.
Moody’s cited favourable credit market conditions as being likely to encourage pre-financing in 2017 as another important factor driving the rise in financial leverage; despite the recent hike in rates, European re/insurers are expected to benefit from taking advantage of still low-interest rates.
The rating agency also said it expects re/insurers will be taking advantage of low-interest rates to lock in lower borrowing costs to refinance maturing debt ahead of schedule or above refinancing needs.
Tier 2 capital is expected to remain most in-demand for new issuances, driven by large insurers’ high Tier 2 capacity, but Moody’s notes the low-interest rate environment has made senior debt and Tier 3 issuances become increasingly attractive options; “Several European insurers, Aviva, Allianz, AXA and Aegon, successfully issued senior debt with coupon rates below 1.5% in 2016.”
According to Moody’s market report, capital optimisation will also play a role in driving up rates of financial leverage as insurance and reinsurance firms taking action to better leverage their capital efficiency is likely to increase the portion of debt to equity; “We expect active capital management in the form of special dividends, progressive dividend strategies and share buybacks, to remain a feature of the European insurance sector.
“These actions, coupled with a lower earning potential for the sector, will slow down the pace of shareholders’ equity growth.”
The rating agency further predicts these market conditions will drive insurers to look more closely at the quality of capital; “particularly when call dates for grandfathered Tier 1 securities get closer,” and notes that; “Presently, insurers’ capital structure remains of a generally good quality, although the loss absorbing capacity of old style (i.e. Solvency I) instruments is limited.”
In addition, Moody’s says active capital management in the form of special dividends, progressive dividend strategies and share buybacks will remain a feature of the European insurance sector throughout 2017, and coupled with a lower earning potential for the sector, will contribute to driving up the portion of debt to equity and consequently raising rates for financial leverage.
